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EUR/USD to rise beyond 1.30 on force of flows - Danske Bank

The EUR/USD pair is set to move higher still as negative rates and QE are phased out over the medium to long term according to analysts from Danske Bank. They see the impact of a ’normalisation’ in rate spreads and portfolio flows as key factors to watch. 

Key Quotes: 

“We have for long been arguing that the undervalued EUR/USD should eventually appreciate due to euro-supportive fundamentals (such as the current account and productivity factors. This ‘reverse gravity’ has been looming for long but undervaluation in the cross has been sustained by continued monetary-policy divergence – at least until earlier this year.”

“One thing to note is that relative short-term rates have failed to explain the uptick in EUR/USD this year. Beyond valuation measures, equity and speculative flows have turned recently to support the single currency and a ‘normalisation’ of notably euro-zone debt flows could be instrumental for where EUR crosses will be headed in the years ahead.” 

“We do not expect any significant dips materialising from current levels though, as we deem that the EUR/USD uptick also reflects a permanently smaller euro political risk premium, which is justified in our view but not captured by this model. Adjusting for the current gap between spot and model, a 5Y projection suggests that this ‘normalisation’ in rates and flows in itself could send EUR/USD firmly above 1.30.”

“On a broader note, the move in EUR/USD from 1.05 to current levels – which we have dubbed ‘Rebound part I’ – was seemingly largely caused by speculative flows reversing and equity flows supporting the EUR. Support from equity and speculative flows may now be fading a tad in the very near term, but the potential for a debt-flow reversal is a key reason why we have a ‘Rebound part II’ on our radar on a 6-12M horizon. A key determinant of whether EUR/USD will be able to make it to, for example, 1.30 is whether the ECB is ready to accept this and apply the measures needed to go against it if necessary. In our view, a further uptick in EUR/USD should not in itself pose a problem for the ECB if it takes place gradually, and if it is supported by a strong domestic economy.”

“Moreover, the ECB will be focused on the effective EUR exchange rate, which has moved less recently than EUR/USD and is likely to move less going forward as well, as other central banks are set to ‘normalise’ policy too. Near term, relative rates are certainly pointing to downside for EUR/USD: the Fed is set to out hike market expectations, and the ECB is eyeing a very slow pickup in core inflation next year. Key to whether we will see more than just a shallow and short-lived drop in EUR/USD on a 1-3M horizon could be whether German wage inflation picks up. However, longer term, watch out for a eurozone debt flow reversal to be triggered and facilitate another upward level shift in EUR/USD.”

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